Who would have predicted that the London Interbank Offered Rate would be dominating the news on a daily basis? Unlike the 2008 banking crisis, which centred on some fairly difficult concepts like credit default swaps and securitisation, Libor is fairly straightforward to grasp. But that has not prevented it from being open to abuse. Astonishingly, the process for setting Libor is not subject to any direct legal regulation or supervision.

Libor is intended to be the average rate at which major banks lend short-term money to one another (for specified periods). The reason it is so important is because critical financial products are expressly linked to Libor.

Understandably, much press coverage has been devoted to those personal mortgages and credit cards which use Libor as a reference rate, but the major products which are affected by it are interest rate swaps. Swaps enable banks to exchange fixed-rate interest for variable rate interest over a set period of time. They are pretty clever products because they enable swaps traders simultaneously to take a number of views over the life of the swap – 'trading the curve', in the jargon. Literally billions of pounds of swaps are traded every day, in all the major currencies, mostly directly between speculating banks but also with major businesses who want to insulate themselves against interest rate movements and even local authorities. The variable rate in the swap is usually agreed to be set at Libor. So if Libor has been rigged, then clearly the financial implications are absolutely huge. It has been estimated that $250tn ofswaps use some form of Libor as a reference rate.

The process for ascertaining Libor is really quite remarkable. It is not done by averaging the rates at which banks actually lend to one another for any given period of time. It is calculated by asking member banks (there are between eight and 20 for each currency) what rate they think they could borrow funds on the interbank market. Someone simply asks each bank for their perception of where the market is. And of course that is very much open to abuse. A member bank which is asked for its Libor quote will typically have on its books a large number of swaps whose values are referenced to Libor. Some of those swaps may have been traded that day; others may be long-term positions. But the swaps' market value will all be directly affected by Libor, and the bank itself can influence where Libor is set according to the quote it provides, which will go into the pot. The bank will know the reference days on which it is due to pay out or receive Libor on swaps it has traded and whether an uptick or downtick in the rate would improve or diminish its portfolio. And, of course, even a very small change in Libor may make a huge difference to a multi-billion pound portfolio of swaps. Traders who provide the quotes may have their bonuses determined by the value of portfolios which are affected by Libor. It does not require a great deal of imagination to see why they might succumb to temptation.

So why on earth is this critical reference rate not centrally regulated? It is essentially a historical quirk that the British Bankers Association oversees the Libor collating process, which was invented in the 1980s when swaps trading really took off. The BBA has no regulatory powers and it co-ordinates a wholly private activity, even though the member banks are individually regulated by the FSA. And swaps are 'over-the-counter' products (not traded through any centralised exchange). Remarkable though it is, arguably the most important reference figure for interest rates is not subject to direct regulatory and supervisory controls.

And why is Libor not calculated by using actual rather than perceived rates? Well, the arguments against are pretty thin in my view. It's true that actual rates are constantly changing throughout the day, but that is no reason to prevent a real snapshot at a given point in time being used. Of course, there is no guarantee that any particular bank would be able to obtain a given amount of funds for a specified period but unless there is exceptional market turbulence most banks can easily obtain short term money from another bank in 'reasonable market size'. There is no reason why major banks could not be forced to provide details of the rates at which they actually lent short-term money over the day and for those to be averaged out. Any commercial sensitivity - say, a bank not wishing to reveal that it had borrowed heavily on the short-term market that day - could be addressed by anonymisation.

So what needs to be done in the long-term to prevent recurrence and improve banking standards? Problems with Libor have been known for many years. During the exceptional liquidity problems surrounding the 2008 banking crisis, for example, some suggested that Libor was too low given the acute difficulties in actually borrowing money. Indeed, as the Bank of England memo appears to show, the authorities were so concerned not to cause paralysis in the banking system that they encouraged Barclays to give lower Libor quotes, with a view to keeping the average down.

If that is correct, then the conduct of the authorities and all the major banks needs to be assessed in the round. The sheer scale of that task and the fact that London's status as the world's premier financial market is at stake must surely strengthen the case for a full blown, judge-led public inquiry, rather than a parliamentary one. The allegations of political bias surrounding the media select committee's report in May on phone hacking and the lack of any forensic questioning showed the inherent limitations of a parliamentary-led inquiry.

But any inquiry, judicial or parliamentary, will not wish to ride roughshod over the FSA and the Serious Fraud Office, which have yet to complete their investigations. The FSA will be considering whether the criminal financial services law prohibiting misleading market statements can in fact be applied to attempted Libor-fixing, which is an unregulated, private activity. The SFO will be assessing whether there is any evidence of conspiracy to defraud sufficient to provide any realistic prospect of convictions. And it is likely there will also be a volley of parasitic civil litigation by those who entered into transactions with banks which have admitted attempted rate-manipulation, if they can show some actual effect on rates.

Do we need new laws or just more rigorous enforcement? That may depend on the outcome of the FSA and SFO investigations. But perhaps the most telling indicator was the difference between the public's reaction and the response of the markets when the Barclays news first broke. Details of Barclays' vast fine emerged on June 27, but the markets took things in their stride and Barclays' share price remained largely unchanged over the day. It was only when the political firestorm ignited the following day that the markets took flight – recognising that wider implications were plainly gathering pace. If, as the initial reactions suggested, the bankers had already 'priced-in' Libor misconduct, then major issues need to be addressed. And if the authorities acquiesced or were complicit in any wrongdoing then we have a very serious problem indeed. At the very least, there is a strong case for the BBA to be regulated by the FSA and for Libor to be set using actual data, ratherthan estimates.

Alex Bailin QC is a barrister at Matrix Chambers whose practice includes business crime and financial services. He was previously a swaps trader in the City